Is Alcatel so ugly it’s beautifu?
Posted on September 3, 2008
While we were busy doing a little real work on Palm we noted the change in management at Alcatel with a little bit of interest. Alcatel doesn’t fit into our research themes very well as it’s basically a giant telco conglomerate at this point but we’ve had some very profitable history with such ugly companies in the past. (Unisys and Sterling Software both come to mind, very boring to our clients but we find 200-300% returns in fairly large stocks interesting enough in their own way.)
Alcatel is a beast with something in the range of an $18B run rate and around $1.5B in EBITDA generation per year. As a conglomerate it’s everywhere but without much of a unifying strategy or operating plan. The company has a long history of volatile growth and margins. Operating margins over the last 14 years have been more negative than positive with the peak being 11% back in 1998. It’s probably fair to say the company has not made money on a cumulative basis in the last decade or two. The ability for the company to come up with a plan that will create some sustainable improvements in operating margin is unknown at this point. The scale of the problems doesn’t seem to be addressed by a simple management change at the top.
Still investors love a company with lots of "fat" to trim. It’s worked wonders for IBM and HP in the past. But of course for Alcatel the markets and situation is a bit more complicated. But Alcatel has been improving the mix of business to be more services and enterprise (about 1/3 of the total now) that at least have double digit operating margins. If management can drive these forward while rationalizing the massive overhead and corporate cost structure investors would get interested.
However when we do a little back of the envelope figuring on potential share price gains it dampens our enthusiasm. If the company can get to a 5% operating margin the EPS is something like 40c/share the shares already reflect a 15x multiple of that. It just means we probably have to wait until we get some cues from management as to what they plan and then spend a little more time with the business model to see how far they might be able to go.
Meanwhile we think we have more reason to keep working on PALM.
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